John Hussman: Extreme Investor Bearishness Creates Favorable Conditions

Excerpt from the Hussman Funds' Weekly Market Comment (10/20/08):

I'll say that again. The real object of interest is the long-term stream of cash flows that the company will deliver into the hands of shareholders over time (beware of companies that quietly dispose of their reported earnings through grants of stock and options to management and employees). Nearly all of the value of a stock is loaded into the “tail” of that stream – 5, 10, 20 years out and beyond. As Buffett notes “fears regarding the long-term prosperity of the nation's many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”

The rush to dismiss Buffett's advice underscores the extreme level of bearishness among investors here. According to Investors Intelligence, just 22.4% of investment advisors are presently bullish. This matches the lowest extremes we've seen in decades. Extreme negativity of investors has generally been a useful contrary indicator of stock market prospects. That doesn't ensure that stocks have registered their final lows, but it contributes to a set of historically favorable conditions here.

At present, we observe not only undervaluation coupled with negative sentiment, but also extreme volatility that has historically accompanied important market troughs. Similar spikes in actual (e.g. 44-day) volatility were observed in July 1962, June 1970, October 1974, December 1982, December 1987, October 1998, and September 2002, all which were associated with important market lows.